An International Monetary Fund (IMF) mission visited Vilnius during
November 15–21, 2019, to discuss recent economic developments and policy
priorities with the Lithuanian authorities. At the conclusion of the visit,
Mr. Borja Gracia, IMF mission chief for the Republic of Lithuania, made the
following statement:
“Growth in Lithuania in 2019 remains strong and balanced in the face of
a global slowdown. The tight labor market and strong wage growth have supported private
consumption while a better utilization of EU funds has helped accelerate
investment, particularly in construction and transportation. The current
account surplus strengthened further, supported by increases in export of
services related to transport, which almost doubled over the last four
years. Credit has continued to grow, yet at a moderately slower pace than
in 2018, due to a decline in credit to non-financial corporations that are
increasingly using alternative funding sources such as issuing bonds. The
banking sector remains well-capitalized, liquid, and profitable.
“There is no evidence so far of high wage growth affecting the
economy’s competitiveness.
Despite continued strong wage growth, recently led by the public sector
amidst moderating private sector wage developments, inflation has declined.
The less productive non-tradable service sectors have experienced higher
inflation as firms passed higher labor costs to prices to preserve
profitability. By contrast, price increases in exporting companies are
lower as external competitiveness and profitability are supported by higher
productivity. While this trend has so far not dented the competitiveness of
the economy, raising productivity via structural reforms is crucial to
sustain high wage growth going forward. However, the authorities’ reform
agenda has so far failed to deliver in key areas. In health and education,
the upfront wage increases have not been complemented by other critical,
but socially sensitive, reform areas. The systems remain oversized at the
cost of lower quality, hindering the efforts to boost productivity and
competitiveness.
“On the 2019 budget, fiscal risks to revenue and expenditure have
materialized and will have a lasting impact.
The small surplus projected for 2019 will fall short of the budget due to
revenues that have not kept up with output growth and a higher wage bill
and social spending, especially poorly targeted child benefits. With growth
exceeding expectations and higher than last year, fiscal policy in 2019 is
unnecessarily pro-cyclical.
“The initial 2020 budget proposal sets adequate fiscal targets but
relies on optimistic revenue projections.
An overall balance of 0.2 percent of GDP, if achieved, will translate into
a broadly neutral fiscal stance, which is adequate given the cyclical
position of the Lithuanian economy. However, overly optimistic improvements
in tax administration, unrelated to changes in tax policy, would be
required to achieve such goals. Similar projected improvements did not
materialize in 2019 and are unlikely to do so next year. Furthermore,
proposals for new and modest real estate and environmentally related
revenue measures, in line with past IMF recommendations, have proved
politically challenging and are unlikely to be approved.
“Lithuania struggles to find the right balance between increasing
demands for better public services and a competitive tax environment to
attract investment. This has resulted in budget rigidities that have become apparent this
year and will remain going forward. In this environment, further efforts
should be made to increase the efficiency of the tax system as well as its
expansion through environmental and real estate taxes. At the same time, it
is critical to enhance the efficiency of public spending, particularly in
education and healthcare, with the focus on raising long-term growth. This
will also require better targeted social spending. Pension increases should
preserve the financial sustainability of the system as guaranteed by the
existing indexation formula while addressing pressing demands to ensure its
social sustainability.
“Economic growth is expected to moderate in 2020 towards more
sustainable levels.
Domestic demand is expected to reduce its contribution to growth with
slower growth in employment and wages as well as slower investment growth
due to a slowdown in the absorption of EU funds, which is particularly high
this year. Meanwhile, slower export growth due to weaker external demand is
also expected to weigh on growth.
“Risks remain tilted to the downside.
Domestic risks are related to political uncertainty around the budget,
upcoming parliamentary elections next year, and the lack of progress in
structural reforms. External risks are related to uncertainty surrounding
trade tensions, Brexit, and the European Commission’s Mobility Package,
with the latter having a potentially large impact on the recently booming
transportation sector. “
